Illinois is on track to become the first U.S. state to have its credit rating downgraded to "junk" status, which would deepen its multibillion-dollar deficit and cost taxpayers more for years to come.
S&P Global Ratings has warned the agency will likely lower Illinois' creditworthiness to below investment grade if feuding lawmakers fail to agree on a state budget for a third straight year, increasing the amount the state will have to pay to borrow money for things such as building roads or refinancing existing debt.
The outlook for a deal wasn't good Saturday, as lawmakers meeting in Springfield for a special legislative session remained deadlocked with the July 1 start of the new fiscal year approaching. That should alarm everyone, not just those at the Capitol, said Brian Battle, director at Performance Trust Capital Partners, a Chicago-based investment firm.
"It isn't a political show," he said. "Everyone in Illinois has a stake in what's happening here. One day everybody will wake up and say 'What happened? Why are my taxes going up so much?'"
Here's a look at what's happening and what a junk rating could mean:
Why now?
Ratings agencies have been downgrading Illinois' credit rating for years, though they've accelerated the process as the stalemate has dragged on between Republican Gov. Bruce Rauner and the Democrats who control the General Assembly.
The agencies are concerned about Illinois' massive pension debt, as well as a $15 billion backlog of unpaid bills and the drop in revenue that occurred when lawmakers in 2015 allowed a temporary income tax increase to expire.
"In our view, the unrelenting political brinkmanship now poses a threat to the timely payment of the state's core priority payments," S&P stated when it dropped Illinois' rating to one level above junk, which was just after lawmakers adjourned their regular session on May 31 without a deal.
Moody's did the same, stating: "As the regular legislative session elapsed, political barriers to progress appeared to harden, indicating both the severity of the state's challenges and the political difficulty of advocating their solutions."
What is a 'junk' rating?
Think of it as a credit score, but for a state (or city or county) instead of a person.
When Illinois wants to borrow money, it issues bonds. Investors base their decision on whether to buy Illinois bonds on what level of risk they're willing to take, informed greatly by the rating that agencies like Moody's assign.
A junk rating means the state is at a higher risk of repaying its debt. At that point, many mutual funds and individual investors — who make up more than half the buyers in the bond market — won't buy. Those willing to take a chance, such as distressed debt investors, will only do so if they are getting a higher interest rate.
While no other state has been placed at junk, counties and cities such as Chicago, Atlantic City and Detroit have. Detroit saw its rating increased back to investment grade in 2015 as it emerged from bankruptcy — an option that by law, states don't have.
What will it cost?
Battle says the cost to taxpayers in additional interest the next time Illinois sells bonds, which it inevitably will need to do in the long-term, could be in the "tens of millions" of dollars or more. The more money the state has to pay on interest, the less that's available for things such as schools, state parks, social services and fixing roads. "For the taxpayer, it will cost more to get a lower level of service," Battle said. Comptroller Susana Mendoza, who controls the state checkbook, agreed. "It's going to cost people more every day," she said. "Our reputation really can't get much worse, but our state finances can."
Other impacts?
Because the state has historically been a significant funding source to other entities, such as local government and universities, many of them are feeling the impact of Illinois' worsening creditworthiness already. S&P already moved bonds held by the Metropolitan Pier & Exposition Authority and the Illinois Sports Facilities Authority — the entities that run Navy Pier, McCormick Place, and U.S. Cellular Field — to junk. Five universities also have the rating: Eastern Illinois University, Governors State University, Northeastern Illinois University, Northern Illinois University and Southern Illinois University.
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Before the recent string of upgrades, all three major rating agencies - including Moody's Investors Service and Fitch Ratings
Fitch Ratings
Fitch Ratings Inc. is an American credit rating agency and is one of the "Big Three credit rating agencies", the other two being Moody's and Standard & Poor's.
Junk bonds are a kind of bond or debt investment that is rated below investment grade. The junk bond rating means that there is a greater risk that the issuer will default on the debt, relative to investment-grade bonds.
However, S&P also cites Illinois' high unfunded pension liabilities of $140 billion — and the “conservative” plan to have that 90% funded by 2045 — as a detrimental factor impacting Illinois' rating.
On Tuesday, Fitch Ratings became the last of the "big three" credit rating agencies to upgrade Illinois' credit rating to an "A" level. This is the ninth such upgrade since Gov. JB Pritzker took office after several years of downgrades.
Junk bonds have a lower credit rating than investment-grade bonds, and therefore have to offer higher interest rates to attract investors. Junk bonds are generally rated BB[+] or lower by Standard & Poor's and Ba[1] or lower by Moody's. The rating indicates the likelihood that the bond issuer will default on the debt.
In short, it means that the government may not have enough money to pay back what it has borrowed. A 'non-investment grade speculative' is called 'junk status' in investment shorthand.
For Fitch Ratings, a triple-A or AAA rating is the highest investment grade and signifies that its debt is an exceptionally low credit risk. A rating of AA+ represents very high credit quality; An "A" means high credit quality, and BBB is a satisfactory credit quality.
A poor credit history can have wider-ranging consequences than you might think. Not only will a spotty credit report and low credit score lead to higher interest rates and fewer loan options, it can also make it harder to find housing and obtain certain services. In some cases it can count against you in a job hunt.
Illinois's financial problems stem mostly from unfunded retirement obligations that have accumulated over the years. Of the $292.1 billion in retirement benefits promised, the state did not fund $144.2 billion in pension and $56.1 billion in retiree health care benefits.
Among them is the state's pension gap, which has expanded to $142 billion. The unfunded pension liability across Illinois's five retirement systems contributes to the state's historical imbalance between revenue and spending. “The bottom line is we have a structural deficit in Illinois,” said Ralph M.
In the fiscal year of 2022, Illinois' state debt stood at about 65.09 billion U.S. dollars. Comparatively, the state's debt was approximately 28.83 billion U.S. dollars in 2000.
Standard & Poor's, for instance, has a credit rating scale ranging from AAA (excellent) and AA+ all the way to C and D. A country with a rating below BBB- is considered to be a speculative grade or a junk bond, which means it is more likely to default on loans. (Government is R2. 2trillion in debt. 50.7% of our GDP.
While Moody's credit ratings have proven to be good predictors of creditworthiness, Moody's cannot represent our ratings to be -- nor should investors or other observers expect them to be -- performance guarantees.
Ford (F 0.69%): Ford has been rated as investment-grade in the past, but the company lost its investment-grade ratings in 2020 due to the COVID-19 pandemic and global economic collapse. Its junk bonds still trade at a premium, reflecting the company's legacy status.
'BBB' National Ratings denote a moderate level of default risk relative to other issuers or obligations in the same country or monetary union. 'BB' National Ratings denote an elevated default risk relative to other issuers or obligations in the same country or monetary union.
A junk stock won't have much in the way of services, products, assets, or revenue. Instead, they'll probably have a shady CEO, a confusing product, and a low stock price.
Junk bonds represent bonds issued by companies that are financially struggling and have a high risk of defaulting or not paying their interest payments or repaying the principal to investors. Junk bonds are also called high-yield bonds since the higher yield is needed to help offset any risk of default.
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